Monday, March 21, 2011

Time for Gold to Shine? USD Breaks 3-year Trend Line

As Mark Twain said, “History does not repeat itself, but it does rhyme.” We may be having déjà vu all over again with the 1970s inflationary period which was characterized by surging commodity prices and a weak USD. Gold’s most spectacular returns during the 1970s came in the later stage of its secular bull market, and one of the tipping points that pushed gold into overdrive was a bearish break of a multi-year trend line for the USD Index. We just had a trend line break in the USD that looks uncannily similar to the 1970s break and if history is any guide we could see a pretty explosive move in gold to the upside if the USD bearish break picks up steam.

To see what I am referring to, in the chart below I have overlaid the USD Index and gold’s movements from 1972-1980 and shifted them forward in time to align with the current USD Index starting from 2007. As you can see, when the USD Index broke its trend line support (red line in middle panel) gold then began a monster run and rallied 353% in just under a two year period for an annualized return of 123%.

Source: Bloomberg

Looking at the chart below, the similarities between the USD in the 1970s and the present case diverged as the USD remained stronger for a longer period with its trend line break coming four years after its low while the present is occurring just after three years. Is the USD’s decline being accelerated by Helicopter Ben Bernanke’s QE programs? Sure looks like it.

Source: Bloomberg

Shown below is a close up of the USD Index breaking its three year support. Some may be hesitant to call this a real break as it is only marginally below its trend line, though I believe this is the real deal as the USD is universally weak against a global basket of currencies. Shown in the second image below is the current USD Index (on top) along with my G10 USD Index (USD equally weighted among the other G9 countries) breaking below its 2008 lows. The third panel in blue shows the Real Trade Weighted USD breaking to ALL-TIME LOWS, and the Nominal Trade Weighted USD Index showing a material trend line break. While not shown, my Latin American USD Index and my Asian USD Index are also breaking to new lows. With such widespread weakness in the USD in other currencies, the break in the USD Index looks like the real thing, which may push gold to new all-time highs!

Source: Bloomberg

Source: Bloomberg

A weak USD isn’t the only catalyst to send gold prices higher, so too is the trend in real interest rates. Shown below is gold in black and 5-year (orange) and 10-year (red) real interest rates shown in the right axis and inverted for directional similarity. You can see that both 5-yr and 10-yr real interest rates are declining (rising in chart) and are supportive of higher gold prices.

Source: Bloomberg

In short, the USD may not bounce back as Fed Chairman Ben Bernanke’s QE programs are taking its toll on the greenback. That it is also universally weak against global currencies at the same time real US interest rates are falling, gives two very bullish catalysts for gold that may push it to a new all-time high.